Evolving Role of FP&A: The Power of First Principles Thinking and Agility in a Changing Environment
Introduction As we’re entering a new bank earnings season, we're set to see how Net Interest Margins (NIMs) have developed in a landscape where deposit prices are on the rise and the proportion of non-interest bearing deposits is declining. Amidst this volatility, and as central banks juggle skipping, pausing, or sustaining heightened levels for extended periods, a shift in mindset is vital for the finance and FP&A function within banks.
In this scenario, the financial teams within banks need to adapt and think in new ways. It's not just about working faster, but working smarter. We need to identify what's really important and share this understanding with the wider business.
That's where the idea of First Principles Thinking comes in. It's a way of looking at problems that cuts through the noise to what's fundamental. In this blogpost, I aim to clarify my thoughts on how we can use this approach to give businesses a clear view of what they might expect in different scenarios, helping to guide their decisions in these uncertain times.
Section 1: Understanding First Principles Thinking I like the concept of "First Principles Thinking", but what can it mean when applied to finance. How can we balance being data-driven with a need to sometimes ignore past trends to stay relevant in an ever-evolving market?
First Principles Thinking provides a mindset to challenge our foundational beliefs, dissect complex problems into their core elements, and formulate innovative solutions based on these fundamental truths. It encourages us to navigate beyond historical data and conventional wisdom, a strategy particularly useful in unpredictable environments where a reliance on past trends may lead to erroneous forecasts.
For instance, let's view forecasting through the lens of First Principles Thinking. Rather than attempting to predict the future with absolute precision—a futile endeavour in the current phase of the market—this approach suggests we view forecasts as compasses, not crystal balls. Advocated by thought leaders like Shane Parrish on Farnam Street, such a perspective guides us through the intricacies of the financial landscape, illuminating key drivers and potential shifts.
In essence, by adopting First Principles Thinking, we shift our approach to forecasting. We move from striving for perfect prediction to understanding the dynamics of our market, contemplating potential changes, and providing decision-makers with a well-rounded view of the possible scenarios. This approach equips us to navigate the dynamic environment of finance with agility, foresight, and strategic insight.
Section 2: Embracing Agility in FP&A I’ve experienced that Financial Planning & Analysis (FP&A) is seen as a somewhat passive function, focused on reporting and data analysis. However, introducing an agile mindset can transform FP&A into a proactive, learning-oriented business partner. Agile forecasting isn't about achieving perfect forecast accuracy, but about understanding key business drivers and potential market shifts.
This shift towards agility is a holistic approach that includes taking into use the technical capabilities of the tools you have in the organization, as well as combining empathy and data focus. In order to be successful, your team should be on the same level in values, behaviours and skills, from which especially areas such as data literacy, storytelling and strategic decision-making, are highlighted by McKinsey.
Both McKinsey and Gartner's 2023 Leadership Vision for FP&A advocate for agility in FP&A. They suggest that an agile FP&A function is more closely aligned with broader business objectives, offering the necessary tools to navigate the changing business landscape. Agility in FP&A providing robust decision-making support, helping organizations flourish in volatile markets.
Agile FP&A also resonates with one of Gartner's identified priorities - the elevation of finance's role in integrated business planning. This involves defining, achieving consensus on, and driving accountability for actions with financial implications. When finance becomes a proactive player in business planning, it can bridge any gaps and ensure alignment with overall business goals. See for example two resources from the Business Partnering Institute: the Planning and Forecasting Manifesto and the FP&A section in their CFO Guide to Managing the Finance Function.
By embracing this strategic shift, FP&A can facilitate more objective, value-driven decision-making, fostering a company-wide culture of learning and iterating. In essence, agile FP&A shifts from a mere reporting function to an active partner in strategic planning and decision-making, thus contributing significantly to business success.
Section 3: The Intersection of First Principles Thinking and FP&A
Merging First Principles Thinking with Agile FP&A unlocks a powerful synergy that reinforces our adaptability and strategic foresight. It amplifies our capacity to not only anticipate but also respond effectively to the dynamic market trends.
The core of this synergy lies in using First Principles Thinking to break down and understand complex financial issues. This methodology encourages us to question traditional assumptions, making it possible to craft fluid, adaptable strategies rather than clinging to rigid, outdated practices.
Agile FP&A, with its focus on understanding market dynamics over striving for perfect forecast accuracy, complements this perfectly. By embracing this combined approach, our forecasts transition from attempting precision to acting as guides that help us navigate market complexities and inform our strategic decisions.
In essence, synergizing First Principles Thinking with Agile FP&A enhances our ability to understand, learn, and adapt amidst market volatility, making our FP&A function not just resilient but also a driving force in navigating business uncertainties. By this, we elevate our financial planning from a reactive process to a proactive strategic function.
Section 4: Using Feedback for Continuous Organizational Learning Peter Senge's "The Fifth Discipline", a source of inspiration I use in every other post, focuses on the power of continuous learning, a foundation for having agility and innovation in FP&A. The concept of continuous learning emphasizes the need for progress over perfection and iterative thinking.
Among the concepts that I especially appreciate from the book are feedback loops that are crucial catalysts for evolution, enabling us to refine our forecasts and strategies. By having conscious feedback loops in place, we can measure the impact of our approaches, identify potential gaps, and evolve our methods accordingly in order to ensure we are relevant and impactful.
By embracing continuous learning and fostering feedback mechanisms, we transform our FP&A function into a strategic asset, capable of driving resilience and adaptability in changing market conditions.
Conclusion In an era marked by volatility, traditional roles and assumptions within the FP&A function must evolve. This transformation can be achieved through the integration of First Principles Thinking and agility, establishing a culture centered on continuous learning.
By adopting the Scout Mindset, which urges us to pursue truth and challenge existing norms, we can enhance the resilience and relevance of FP&A functions. This mindset can help us explore new territories, test assumptions, and refine strategies based on feedback.
Thus, the call to action for FP&A professionals is to become not just financial stewards, but 'scouts' for their organizations, guiding the way towards strategic growth in a continually evolving market landscape. Embrace this mindset shift and step up to the challenge. Paraphrasing one CFO thought leader “FP&A used to record history. Now they make history.”